IAS 2 Inventory PDF

IAS 2: INVENTORIES
BACKGROUND AND INTRODUCTION

 Prescribes the accounting treatment for inventories.
 The main issue with respect to accounting for inventory is
the amount of cost to be recognized as an asset.
 Provides guidance on the determination of the cost and
subsequent recognition of expense (including write-down
of inventory to its net realizable value).
 Provides guidance on the cost flow assumptions (“cost
formulas”) that are to be used in assigning costs to
inventories
Scope
 IAS 2 applies to all inventories, except
» Work in progress under construction contracts and directly
related service contracts (IAS 11, now IFRS 15, Construction
Contracts)
» Financial instruments
» Biological assets related to agricultural activity and
agricultural produce at the point of harvest (under IAS 41,
Agriculture)
Scope
 This Standard does not apply to the measurement of
inventories held by
» Producers of agriculture and forest products
» Commodity brokers-traders who measure their inventories
at fair value less cost to sell.
DEFINITIONS OF KEY TERMS
 Inventory. An asset that is
» Held for sale in the normal course of business
» In the process of production for such sale
» In the form of materials or supplies to be used in the
production process or in the rendering of services
 Net realizable value. The estimated selling price in the normal
course of business less estimated cost to complete and estimated
cost to make a sale.
 Fair value. The amount at which an asset could be exchanged, or a
liability settled, between knowledgeable, willing parties in an
arm’s-length transaction.
INVENTORY ISSUES
Classification
Inventories are assets:
 items held for sale in the ordinary course of business, or
 goods to be used in the production of goods to be sold.
Businesses with Inventory
Merchandising or
Manufacturing
Company Company
LO 1
INVENTORY ISSUES
ILLUSTRATION 8-1
Classification
 One inventory
account.
 Purchase
merchandise in
a form ready
for sale.
LO 1
INVENTORY ISSUES
ILLUSTRATION 8-1
Classification
Three accounts
 Raw Materials
 Work in Process
 Finished Goods
LO 1
INVENTORY ISSUES ILLUSTRATION 8-2
Flow of Costs through
Manufacturing and
Merchandising Companies
Classification
LO 1
MEASUREMENT OF INVENTORIES
 “lower of cost and net realizable value.”
 COST OF INVENTORIES
» 1. Costs of purchase
» 2. Costs of conversion
» 3. “Other costs” incurred in bringing the inventories to
their present location and condition
Cost of Inventories
 The costs of purchase constitute all of
» The purchase price
» Import duties
» Transportation costs
» Handling costs directly pertaining to the acquisition of
the goods
 *Trade discounts and rebates are deducted when arriving
at the cost of purchase of inventory.
Cost of Inventories
 Conversion Cost consists
» Direct labor
» Variable and Fixed manufacturing overhead
 Other costs
» Costs that are incurred in bringing the inventories to their present
location and condition.
» An example of such “other costs” is costs of designing products for
specific customer needs.
 Finance cost: Ex: Borrowing cost can be included if permitted by
IAS 23.
CASE STUDY 1
 Brilliant Trading Inc. purchases motorcycles from various countries and
exports them to Europe. Brilliant Trading has incurred these expenses during
2019:
» 1. Cost of purchases (based on vendors’ invoices)
» 2. Trade discounts on purchases
» 3. Import duties
» 4. Freight and insurance on purchases
» 5. Other handling costs relating to imports
» 6. Salaries of accounting department
» 7. Brokerage commission payable to indenting agents for arranging imports
» 8. Sales commission payable to sales agents
» 9. After-sales warranty costs
 Required
» Brilliant Trading Inc. is seeking your advice on which costs are permitted under
IAS 2 to be included in cost of inventory.
Solution
 Solution Items 1, 2, 3, 4, 5, and 7 are permitted to be
included in cost of inventory under IAS 2.
 Salaries of accounting department, sales commission, and
after-sales warranty costs are not considered cost of
inventory under IAS 2 and thus are not allowed to be
included in cost of inventory.
INVENTORY ISSUES
Inventory Cost Flow
ILLUSTRATION 8-3
Two types of systems for maintaining inventory records — perpetual

system or periodic system.
LO 2
Inventory Cost Flow
Perpetual System
1. Purchases of merchandise are debited to Inventory.
2. Freight-in is debited to Inventory. Purchase returns and

allowances and purchase discounts are credited to Inventory.
3. Cost of goods sold is debited and Inventory is credited for

each sale.
4. Subsidiary records show quantity and cost of each type of

inventory on hand.
The perpetual inventory system provides a

continuous record of the balance in both the
Inventory and Cost of Goods Sold accounts.
LO 2
Inventory Cost Flow
Periodic System
1. Purchases of merchandise are debited to Purchases.
2. Ending Inventory determined by physical count.
3. Calculation of Cost of Goods Sold:
Beginning inventory $ 100,000

Purchases, net + 800,000
Goods available for sale 900,000
Ending inventory - 125,000
Cost of goods sold $ 775,000
LO 2
Inventory Cost Flow
Comparing Perpetual and Periodic Systems

Illustration: Fesmire Company had the following transactions
during the current year.
Record these transactions using the Perpetual and Periodic

systems.
LO 2
Inventory Cost Flow ILLUSTRATION 8-4
Comparative Entries—
Perpetual vs. Periodic
LO 2
TECHNIQUES FOR MEASUREMENT OF COSTS
 Brilliant Trading Inc. purchases motorcycles from various countries and
exports them to Europe. Brilliant Trading has incurred these expenses during
2019:
» 1. Cost of purchases (based on vendors’ invoices)
» 2. Trade discounts on purchases
» 3. Import duties
» 4. Freight and insurance on purchases
» 5. Other handling costs relating to imports
» 6. Salaries of accounting department
» 7. Brokerage commission payable to indenting agents for arranging imports
» 8. Sales commission payable to sales agents
» 9. After-sales warranty costs
 Required
» Brilliant Trading Inc. is seeking your advice on which costs are permitted under
IAS 2 to be included in cost of inventory.
WHICH COST FLOW ASSUMPTIONS TO
ADOPT?
Cost Flow Methods

 Specific Identification
or
 Two cost flow assumptions
► First-in, First-out (FIFO) or
► Average Cost
LO 5
Cost Flow Methods
Specific Identification
 IASB requires in cases where inventories are not ordinarily
interchangeable or for goods and services produced or
segregated for specific projects.
 Cost of goods sold includes costs of the specific items sold.
 Used when handling a relatively small number of costly,

easily distinguishable items.
 Matches actual costs against actual revenue.
 Cost flow matches the physical flow of the goods.
 May allow a company to manipulate net income.

LO 5
Specific Identification
 Specific identification method can be applied in
situations where different purchases can be physically
separated.
 Under this method, each item sold and each item
remaining in the inventory is identified.
 The cost of specific items that are sold during a period is
included in the cost of goods sold for that period and the
cost of specific items remaining on hand at the end of a
period is included in the ending inventory of that period.
Specific Identification -Example
 A company made the following purchases and sales during the
month of April 2013:
» The 3,000 units in the inventory on April 30 is composed of 500 units

from purchases made on April 01, 1,500 units from purchases made on
April 12 and 1,000 units from purchases made on April 30.
» Required: Calculate the cost of ending inventory and the cost of
goods sold using specific identification method of inventory valuation.
Solution
 Calculation of ending inventory
» Calculation of cost of goods sold:

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IAS 2: INVENTORIES

BACKGROUND AND INTRODUCTION

Businesses with Inventory

Two types of systems for maintaining inventory records — perpetual

2. Freight-in is debited to Inventory. Purchase returns and

3. Cost of goods sold is debited and Inventory is credited for

4. Subsidiary records show quantity and cost of each type of

The perpetual inventory system provides a

2. Ending Inventory determined by physical count.

3. Calculation of Cost of Goods Sold:

Beginning inventory $ 100,000

Comparing Perpetual and Periodic Systems

Record these transactions using the Perpetual and Periodic

Cost Flow Methods

 Cost of goods sold includes costs of the specific items sold.

 Used when handling a relatively small number of costly,

 Matches actual costs against actual revenue.

 Cost flow matches the physical flow of the goods.

 May allow a company to manipulate net income.

» The 3,000 units in the inventory on April 30 is composed of 500 units

» Calculation of cost of goods sold:

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